Saving capitalism from the capitalists

It is truly a great honour to be invited to give this year´s Hayek lecture, on

all sorts of levels.

I was delighted when I got John Blundell´s letter because the Institute of

Economic Affairs has for so many years done such a marvellous and

important job of promoting the use of reason in our economic and social

policies, which means of course liberalism. It is therefore very pleasing to

be associated with it this evening.

I was also delighted because it is an honour both for me and for the

liberal publication that I represent, The Economist, to join such a

distinguished list of previous lecturers, especially in the year of the

paper´s 160th anniversary.

And finally, of course, like all previous lecturers, I feel hugely honoured,

as well as over-awed, by the association of this annual lecture with the

name of Friedrich Hayek himself. None of us can live up to him, but all

of us must feel a duty to carry on his work.

One of Hayek´s many extraordinary achievements was that in "The Road

to Serfdom" he kept the light of reason shining brightly and clearly

during a time—the second world war—when both unreason and short-

sighted pragmatism were in the ascendant. It is our good fortune today to

live in a far better time, a time when for all its occasional turbulence and

instability reason does stand a chance of getting a fair hearing. Yet we

still need constantly to keep up the argument for reason and for liberty, as

belief in it, among the public and in particular in government, is always

paper-thin.

These may be much better times but they are nevertheless challenging

ones in their own way.

It is a time of terrorism, of threats to our freedom from messianic groups

of violent revolutionaries, whose desire to use the promise of general,

supposedly spiritual aims in the service of their specific ambitions is

reminiscent chiefly of Lenin and the Bolsheviks.

It is a time of war, both of a war of words about war and then of real war,

in pursuit of the aim of reshaping the Middle East and deterring weapons

proliferation, but, as always with wars and with quasi-imperial ventures,

taking the risk of unintended consequences causing new problems even as

old ones may be solved.

All this has occurred at a time of worldwide economic slowdown, in the

wake of some economic crises in the developing world but also a rather

more influential financial boom and bust in the developed world.

That financial bust has been mercifully mild in its effects, in comparison

with previous crashes whose damage was multiplied by banking

collapses. But it has nevertheless left a string of corporate scandals in its

wake. Unemployment has risen, especially in America, Germany and

Japan. Deflation is a fact in Japan, an imminent danger in Germany and a

fear in the United States.

Business is under attack, for the scandals, for excessive pay, for supposed

abuses of pricing in the pharmaceutical industry, for environmental

damage, and, above all, for its association with globalisation.

All this bad news poses big dangers to liberalism. It poses them, in part,

because belief in and understanding of liberalism is always so thin, as

David Henderson explained so eloquently in a previous IEA lecture and

book a few years ago.

It poses them also because it is at times of economic stress, particularly of

rising unemployment, that governments become tempted to curry favour

with domestic interest groups through short-term protectionism.

Furthermore, international tensions add to the temptation to close borders

along with minds, looking inward in revenge at the pain of looking

outward.

There is no coherent case being presented as an alternative to liberalism,

nor to capitalism itself. But incoherence is no obstacle to unreason and

illiberalism. The danger is that many different groups and pressures, with

wholly different and even incompatible aims, may nevertheless overlap

with one another in such a way as to bring about a retreat from liberalism:

the anti-capitalists, the environmentalists, the global justice movement,

the outright protectionists, the many special interest groups are all small

and weak on their own, but their overall effect could still be damaging.

How should liberals respond? In this lecture I would like to suggest four

broad ways in which to do so. Briefly, these concern 1) the real state of

the world; 2) the impact of geopolitical developments on the prospects for

liberty; 3) the discrediting of capitalism during the past two years of

scandal; and 4) the issue that, surprisingly perhaps, now offers a rare

chance for a tactical alliance with some critics of globalisation, namely

farm trade.

THE STATE OF THE WORLD

First, the real state of the world. It is a truth universally acknowledged by

anti-globalisation campaigners and sadly believed and reinforced by

many commentators and the general public that the world has been

getting worse in economic and social terms—that poverty has been

increasing, inequality has been worsening and development has been

failing. All this is attributed to the evils of globalisation, the errors of so-

called neo-liberal policies and the depradations of those financial-market

puppets at the IMF.

Yet this truth is simply untrue.

Far from rising, global inequality has actually been falling substantially.

Not when measured as the gap between the very richest and the very

poorest: that has indeed widened. But if inequality is measured in the way

which is normal within countries, as the distribution of individual

incomes, it has narrowed considerably. Given the rapid growth in China

over the past 20 years, and the less rapid but still healthy growth in India,

that observation makes eminent sense: huge chunks of the world´s

population have been climbing out of poverty.

Two different studies, using different methods, have now come up

with broadly the same conclusion about the distribution of individual

incomes. The studies have been by Xavier Sala-i-Martin of New

York´s Columbia University for America´s National Bureau of

Economic Research, and Surjit Bhalla, a Delhi-based Indian

economist, for Fred Bergsten´s Institute for International Economics.

Both show that, depicted as a bell-curve distribution, the range of

individual incomes shows a bulge moving sharply to the centre in

each of the past two decades. Incomes are becoming more equal and a

global middle class is emerging.

Surjit Bhalla´s book for the IIE, called "Imagine There´s No Country",

also mapped the consequent drop in world poverty. Measured by the

benchmark favoured by the World Bank of income of $2 a day or less,

adjusted to cater for differences in purchasing-power, the proportion

of the world´s population in poverty dropped from 56% in 1980 to

23% in 2000, on Mr Bhalla´s calculations. Thanks to population

growth, the absolute number of people in that category remains large:

more than 1.1 billion. But that is still fewer than in 1990 (1.7 billion)

and 1980 (1.9 billion). Before 1980, the absolute numbers were rising.

That date roughly coincides with the spread of trade and internal-

market liberalisation to many poor countries.

Liberalisation has been working, where it has been tried and where

domestic governmental institutions have permitted it to. Far from a

general increase in inequality and a general increase in the problem of

poverty, as the anti-globalisers claim, the real problem is a very

different one. In effect, a global underclass has been created, as

growth in globalising developing countries has left them behind, and

as a combination of war, instability and disease have made some

countries become even poorer. This underclass dwells of course in

sub-Saharan Africa, as well as in some parts of Asia, including

Pakistan and Central Asia, and parts of Latin America.

Alongside this successful growth in economic liberty there has also

been an impressive expansion of political and civil freedoms. Since

1980, according to the United Nations Human Development Report

(UNHDR), 81 countries have taken "significant" steps towards

democracy, with 33 military regimes replaced by civilian

governments. Of the world´s nearly 200 countries, 140 now hold

multi-party elections. Not all of those that hold elections are fully

democratic, but 82 countries are, and they are home to 57% of the

world´s population.

Recently, it has become fashionable to play down that progress by

pointing out that many of the new democracies have not gone beyond

elections to build the other, essential, protections for liberty: an

independent judiciary, equality before a well-enforced rule of law, and

constitutional limits on the abuse of political power.

Such worries are perfectly fair. Much more progress is needed. Yet

such legitimate points should not be allowed to detract from the basic

progress that has occurred: in the past 20 years the share of the

world´s population living in proper democracies has risen from about

a third to just over half.

Liberty has had a fantastic period of advance, on all fronts.

It is also strikingly and gratifyingly popular. Despite the economic

crises in East Asia, Russia and Latin America during the past six

years, developing countries still seem to want to liberalise their

economies. China has just joined the World Trade Organisation,

bringing the total membership to 146 countries, and Russia is in the

queue for membership, along with 25 others.

A fortnight ago, an opinion poll produced by the Pew Research Centre

of the University of Maryland caught lots of attention. A poll taken in

dozens of countries around the globe, it produced evidence of an

alarming increase in anti-American hostility, in poor countries as well

as rich ones. Naturally, that caught the attention. Yet some other

findings also deserved close scrutiny. People in poor countries were

also asked their view of capitalism and globalisation.

Overwhelmingly, they wanted more of both.

GEOPOLITICS AND IMPERIALISM

That brings me to my second area for attention by liberals: geopolitics.

This could be, and these days often is, the subject of whole lectures,

even books. I do not propose today to offer a long debate on the rights

and wrongs of the war in Iraq (though I think it was right) or in

Afghanistan (ditto), nor of the merits or otherwise of George Bush and

his diplomacy.

What I do want to do is to make a point about imperialism. That word

has come suddenly back into vogue, as has the idea that America is

building a new empire.

I think as matter of intention that is utterly wrong. As a matter of

prediction it could conceivably be proven right—we cannot yet know.

Just as Britain was said in the 19th century to have built an empire in a

fit of absence of mind, it is possible that America may now build one

in a fit of unintended consequences. Against its own will, it might be

forced to occupy Iraq for years, it might be dragged even further into

the conflict between Israel and the Palestinians, and it might even be

dragged into intervention in some other country in the region—Saudi

Arabia, say, or Iran—in which for domestic reasons some sort of

upheaval occurs.

America might, inadvertently, find itself with a sort of empire which it

then finds it hard to rid itself of. But like the Americans themselves,

we should deal with that challenge as and when it presents itself.

For the truth about the modern world is that the word imperialism has

changed its meaning. It is no longer a matter of colonies and

memsahibs. It is a matter of seeking to influence and pressure other

countries, and other parts of the world, to alter the way they do things.

And, in that sense of the word, we are all imperialists now.

The NGOs who want to alter human rights practice or take on medical

tasks. The environmentalists who want to changing logging practices

or change the deals governments do with mining and oil companies.

The economists who want the IMF to support one sort of macro or

micro policy rather than another. Or indeed the military

interventionists who want to bring about regime change in Serbia or

Afghanistan or now Iraq, whether for humanitarian reasons or because

of concern about weapons of mass destruction.

All are imperialists.

The real issue we need to concentrate on is the purpose of imperial

behaviour: is it designed to enable liberty to spread and become

entrenched, or is it an instrument of oppression?

It is on that measure that I think that, imperfect though the United

States of America is as an agent of such liberty, it is the best we have

and deserves, alongside close scrutiny, the benefit of most doubts.

Winston Churchill put it well when in the 1940s he observed that "we

can always rely on the Americans to do the right thing. Once they

have exhausted the alternatives".

Under democratic constraints of their own, and with the ideals of

democracy and free trade firmly embedded in their system and their

thinking, America does, in most cases, have those liberal ideals as its

aim. My belief is that this has been entirely true in the case of Iraq,

just as it is in the rest of the Middle East. By seeking to reshape the

Middle East, in order to permit political and economic freedoms to

spread, I believe they are doing all of us a favour, and we should

encourage them to continue. Failure in this endeavour is what we

should fear, not success. Rather than being sceptical of their aims, as

so many Europeans are, we should hold them firmly to them.

CAPITALISM´S SCANDALS

My third topic I shall be even briefer about, but it is also one in which

America stands at the centre.

The spread of so-called "Anglo-American shareholder capitalism"

has, in the past two decades, been also the spread of liberalism.

It coincided during the 1990s with a technological euphoria, one of

those moments of madness in the financial markets with which history

is filled, when a long-term promise of technological progress becomes

conflated with short-term hopes and fears.

Mostly, recovery from this is a matter of time. The American and

European economies have to adjust to the excesses of debt and over-

capacity that were built up during the new economy boom. But also,

this boom and bust have left capitalism partially discredited.

Much of that discredit is a matter of the scandals, of fraud, insider

trading and accounting deception that took hold in the United States.

The remedy for that lies in the courts and the jails.

But there is another matter arising from this that concerns us all, or

should do. It is essentially what companies were able to do entirely

legally, rather than illegally. And the main symptom of that is

executive pay.

The extraordinary inflation of executive pay in America and Britain

during the 1990s is familiar enough that it needs no elaboration. The

gap between the pay of ordinary workers and the bosses widened from

around 20 or 30 to 1 to 100s or even 1000s to one. In America, though

not really in Britain, the effect on income inequality could be material

enough to bring about political consequences in the future. But the

point that concerns me most is what pay tells us about how companies

are owned and run.

People have worried about the agency problem, the gap in interests

between owners and managers, for hundreds of years, at least since

Adam Smith. What seems to have happened during the 1990s is that

the delegation of power from shareholders to managers went to new

extremes, despite the mantra of "shareholder value" and of "aligning

interests" through performance-related pay and share options.

Executive pay soared because shareholders—the buying side of the

transaction—essentially played no role in controlling or even

influencing the bargaining. The bidding up of pay packages between

companies, in a process remuneration committees couldn´t have

controlled even if they had wanted to, was the result.

There have been piles of recommendations about improving corporate

governance to deal with this and other problems, all of them

worthwhile. But the heart of the matter is the role of the owners, the

shareholders. Shareholders do not want to get actively involved in

monitoring management because to do so is costly and involves free-

rider issues. Managements do not want shareholders involved because

they value their autonomy.

There is, though, a growing cost to this vaccuum of ownership. It is

the discrediting of capitalism in the eyes of the electorate as well as

the workforce, and the handing of a ready-made and convincing

argument to the critics both of capitalism and of globalisation: the idea

that it is all a scam, all a matter of greedy plunder.

The British government has made a helpful move, in my view, by

requiring companies to have an annual vote by shareholders on pay.

But it is only advisory, and only has the power of embarrassment.

What I want to suggest today is that it goes further, and adopts two

recommendations put forward by Bob Monks and Allen Sykes (the

latter of whom is in the audience today). One is that shareholders

above a certain minimum size should be obliged under trust law to

exercise their obligation to vote on company business, including pay,

naturally. And, second, that they should have the power and the

obligation to nominate a slate of non-executive directors themselves.

Neither of these is a panacea, and neither will stop us all having to

think about principal-agent problems. But I do believe that unless we

reintroduce some element of ownership, or of the obligations of

ownership, into shareholder capitalism then governance will continue

to go awry. There will always be abuses, but the question is how

many, and how defensible is the system as a whole in the face of those

abuses.

Perhaps the final point about executive pay, and the vacuum of

ownership that it represents, is that in effect it is a self-inflicted

wound: it hands a cause and an argument to the illiberals, the anti-

capitalists. And it thereby risks a political backlash involving direct

regulation of pay, or penal taxation, of a sort that would do far more

harm.

FARM TRADE

The final of my four points leads on from the battle between the

liberals and the illiberals, though it also connects it to 160 years of the

history of The Economist. The point is a simple one, and it is already

close to the heart of the IEA: that freeing trade in agricultural goods

should be one of the great liberal campaigns of this decade.

The twist, though, is that this issue represents one on which there is a

rare chance of a tactical alliance between liberals and those who are

often campaigners against capitalist freedoms of various kinds. For the

one part of trade that the self-proclaimed "global justice" movement

does seem to want to liberalise is farm trade. Whether the argument is

from Oxfam or from a revolutionary activist such as George Monbiot

of the Guardian, the conclusion is the same: farm protection in

Europe, the USA and Japan not only costs consumers and taxpayers

upwards of £450 billion a year in the rich countries, but it is also one

of the things that holds economic development back in Africa, Latin

America and elsewhere. So, perhaps through gritted teeth, such groups

are now arguing for liberalisation.

The prospects for liberalisation do not, admittedly, look good.

European Union governments seem disinclined to dismantle the CAP

in any substantial way. The Bush administration has with one hand

raised domestic farm subsidies substantially while with the other

proposing a programme to phase out export subsidies under the Doha

round of WTO negotiations. Neither Japan nor South Korea is exactly

seeking to take the initiative in reducing their protections for rice

farmers and others.

There are, though, some brighter signs: Europe and America, in

particular, seem to have begun something of a competition to be seen

as being helpful to the poor, particularly in Africa. Bob Geldof, of all

people, recently praised George Bush for his increases in overseas aid

to Africa for HIV/AIDS and other diseases, and European

governments have responded by raising their own donations. France

has spoken of so-called "temporary" easing of farm restrictions to help

Africa.

So let us repeat and revive the campaign for free trade in food and

other agricultural produce that the IEA has conducted for years, and

which James Wilson, the founder of The Economist, launched our

paper to conduct. At the end of his prospectus for his new publication,

in the summer of 1843, he used the following words:

 And we hope to see the day when it will be as difficult to understand

how an act of parliament could have been made to restrict the food

and employment of the people, as it is now to conceive how the mild,

inoffensive spirit of Christianity could ever have been converted into

the plea of persecution and martyrdom, or how poor old wrinkled

women, with a little eccentricity, were burned by our forefathers for

witchcraft.

Here´s still hoping.

Thank you for listening.